This small, loss making airline could be a sector beater

The aviation industry is rightly worried about the consequences of Brexit, but despite the uncertainty fund managers are continuing to back budget airlines.

Mike Clements, manager of the Oyster Continental European Selection fund is backing EasyJet to prosper. He says: ‘When Brexit hits it might have some short-term negative sentiment towards it [EasyJet]. So it’s a risk but it is still a long-term winner,’ says

Europe’s airport trade association has said that both Britain and EU countries need to make contingency plans for the impact of a no-deal Brexit on aviation.

A deal needs to be agreed between the European Aviation Safety Industry (EASA) and the UK’s Civil Aviation Authority (CAA) so airlines can fly to the European Union post-Brexit, but no progress has yet been made.

Reaping rewards

However, Citywire A-rated Clements, who has a small 0.21% weighting to EasyJet in his European fund, is not worried. He argues that EasyJet is set to reap the rewards of industry consolidation and higher oil prices.

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‘If you look at the airline industry, EasyJet is one of the ways to play the best part of the industry which is the low-cost bit,’ he contends. ‘The business is going to take market share away from established carriers. Bottom line, it is lower cost than British Airways in whatever route it flies.’

The carrier also has an advantage over its competitor Ryanair, in Clements’ opinion, because it flies to ‘proper places’.

‘The cost base is not as low as Ryanair, but it is still much lower than the legacy carriers because it has newer planes, better fuel efficiency, it has cheaper staff and pays lower ground handling costs.

‘EasyJet will carry decent returns simply because its cost structure is untouchable compared to the legacy airlines.’

Impact of higher oil price

Margaret Lawson, manager of the SVM UK Growth fund says: ‘Airlines are a challenging sector for investors. It is hard to set aside the love/hate emotion of personal experience as consumers – the excitement of travel, muted by delays and the pain of hidden charges. Rational investment analysis is difficult.’

She adds that while the rising oil price might be viewed as a reason to avoid the sector, Lawson believes that those who do so are missing the strategic shift the industry is experiencing.

Colin McLean, Lawson’s co-manager agrees, pointing out that older airlines find it harder to pass on costs, typically running less efficient operations. Therefore the higher oil prices could benefit the low cost airlines and accelerate the move away from incumbents.

‘The disappearance of Monarch and Air Berlin, combined with the bankruptcy of Alitalia, brings more pricing discipline into the industry. Not only are ticket prices likely to rise as discounting ends, but new charges for seat selection and luggage are already coming in,’ he says.

‘Raising prices becomes easier as planes approach full capacity. The surviving airlines are also proving more adept at using their customer data to sell hotels, car hire and other travel services… Investors need to strip away the emotion and re-appraise the travel sector. The remaining businesses are creating an industry that looks much more attractive for investors.’

Flybe

One of the remaining businesses is Exeter-based Flybe. The company posted a loss of £19.2 million in the 12 months to March, up from £6.7 million year-on-year.

Despite this, Andrew Hunt, investment director at Aberdeen Standard Investments, believes there is a positive story behind the numbers.

‘Flybe is a recovery story, with highly proactive new management full of good ideas for the business. We believe that in the long-term, Flybe’s future looks attractive.’

Specifically, he highlights three areas he sees the airline improving on.

First, Flybe is currently rationalising its fleet to focus on its most profitable routes. It is also changing its maintenance programme to improve reliability. The business is also implementing a new IT system and digital platform to improve booking and customer experience, to save costs, and to enable integration with other airlines’ flights.

‘In addition, there is a key strategic rationale for Flybe that puts it front and centre of UK passenger aviation,’ says Hunt.

‘Basically, people are flying more, and there is a limited capacity of flying out of London, which has been the historic UK hub – London airports are expensive and massively overcrowded.’

He says this is driving more UK passengers who do not live in London to fly out of the UK from regional airports like Glasgow, Manchester, and Cardiff.

‘Furthermore, passengers tend to prefer avoiding London and it is often more practical. Hence, big airlines like Emirates are increasingly flying out of regional airports.’

Feeder airlines

Flybe also has another key role, for Hunt, as a ‘feeder airline’ for these new and emerging hubs.

‘If you live in Portsmouth, instead of going to London to get to New York, you might go Portsmouth-Cardiff with Flybe, Cardiff-New York with an international carrier. Flybe’s current IT upgrade and integration is key to tying in these feeder flights, and will make it an increasingly essential part of the UK aviation system.’

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